Energy Sector

[Viking]

5 hours ago, Sweet said:

Performance of energy stocks this last month have been woeful.

 

A little more than three weeks ago the broad sector was up nearly 70% for the year.  It was an unsustainable move that was sure to correct.

Today it is up 25% having given up most of its gain these past three weeks.

 

We are exactly 6 months into 2022. Oil was my top pick to make money in 2022.

And oil has performed spectacularly well (especially when compared to the overall stock market which is down 20 to 30%). Russia’s invasion of Ukraine was gas on the fire. However, oil was a trade for me: i actually started exiting my very oversized position in late January and was largely out of oil in Feb/March. Since then i have bought oil a number of times on big sell offs and sold a short time later for a nice quick gain.

 

Over the past week i have been doing a fair bit of reading on oil and gas. And today a light bulb went off for me: i think oil is poised to do well for YEARS. i am starting to drink the secular bull market Kool-Aid. So I was buying oil again today and now oil is 4% of my portfolio. And if oil continues to sell off i will likely buy more.

 

Why do i like oil as a secular investment:

1.) global demand will continue to grow each year by about 1 million barrels per day for the next decade. Demand is doing what it has done for all eternity: grow. People want to live a better life. The best way to do that TODAY (and the next 5 years at least) is hydrocarbons.

2.) supply, already in a deficit, WILL NOT be able to increase production by anything close to 1 million barrels per day for the foreseeable future. The supply function has permanently changed in Western countries. Thank you ESG (oil is a hated and villified industry… who in their right mind wants to work for an oil company today. Good luck attracting young talent).
 

Investors do not appreciate what this now means for oil prices. PERMANENTLY HIGHER PRICES. Yes i know… that is a crazy thing to say… but i think it might be true (at least for the next few years). This means oil companies are going to keep earning outsized profits.
 

Right now profits are going mostly to pay down debt (that ESG thing… banks can’t lend to dirty oil)). Once the debt is paid down shareholders will get paid. By the middle of 2023 the payouts to shareholders could be absolutely NUTS (10-15% dividends based on todays stock prices). 

Here is an update from Amrita Sen… very smart lady:

 

 

Edited July 1, 2022 by Viking

[Dinar]

1 hour ago, Viking said:

We are exactly 6 months into 2022. Oil was my top pick to make money in 2022.

And oil has performed spectacularly well (especially when compared to the overall stock market which is down 20 to 30%). Russia’s invasion of Ukraine was gas on the fire. However, oil was a trade for me: i actually started exiting my very oversized position in late January and was largely out of oil in Feb/March. Since then i have bought oil a number of times on big sell offs and sold a short time later for a nice quick gain.

 

Over the past week i have been doing a fair bit of reading on oil and gas. And today a light bulb went off for me: i think oil is poised to do well for YEARS. i am starting to drink the secular bull market Kool-Aid. So I was buying oil again today and now oil is 4% of my portfolio. And if oil continues to sell off i will likely buy more.

 

Why do i like oil as a secular investment:

1.) global demand will continue to grow each year by about 1 million barrels per day for the next decade. Demand is doing what it has done for all eternity: grow. People want to live a better life. The best way to do that TODAY (and the next 5 years at least) is hydrocarbons.

2.) supply, already in a deficit, WILL NOT be able to increase production by anything close to 1 million barrels per day for the foreseeable future. The supply function has permanently changed in Western countries. Thank you ESG (oil is a hated and villified industry… who in their right mind wants to work for an oil company today. Good luck attracting young talent).
 

Investors do not appreciate what this now means for oil prices. PERMANENTLY HIGHER PRICES. Yes i know… that is a crazy thing to say… but i think it might be true (at least for the next few years). This means oil companies are going to keep earning outsized profits.
 

Right now profits are going mostly to pay down debt (that ESG thing… banks can’t lend to dirty oil)). Once the debt is paid down shareholders will get paid. By the middle of 2023 the payouts to shareholders could be absolutely NUTS (10-15% dividends based on todays stock prices). 

Here is an update from Amrita Sen… very smart lady:

 

 

I agree with everything that you are saying, I would add a couple of points: a) Demand is still down a couple of million barrels a day from 2019 probably caused in part by Chinese lockdowns; b) Iran and Venezuela have potential to increase production materially, may be as much as 1.8MM barrels per day from Iran, and a million or two from Venezuela (unless I screwed up my math.)

[Viking]

1 hour ago, Dinar said:

I agree with everything that you are saying, I would add a couple of points: a) Demand is still down a couple of million barrels a day from 2019 probably caused in part by Chinese lockdowns; b) Iran and Venezuela have potential to increase production materially, may be as much as 1.8MM barrels per day from Iran, and a million or two from Venezuela (unless I screwed up my math.)

@Dinar the supply side of the equation is super interesting. The deficit today is very large:

1.) inventories are at historic lows (and they keep coming down)

https://www.rigzone.com/news/oil_inventories_down_to_dangerously_low_point-24-may-2022-169095-article/

2.) OPEC spare capacity is very limited

3.) Russian supply is constrained due to war

4.) to try and lower prices, governments are releasing massive amounts of oil from strategic reserves. This cannot go on forever and the barrels released will need to be replaced.

- https://science.howstuffworks.com/environmental/energy/us-oil-reserves-last.htm

Yes, new supply from Iran and Venezuela would help increase supply. This is something to monitor moving forward. Bottom line, we have a pretty severe supply problem today that is likely to get worse in the near term. And this supply problem is keeping oil prices over $100. 
—————

On the demand side, it is worth noting we have a severe demand/supply imbalance with China (and large parts of its economy) in lockdown as a result of its zero covid policy…

Edited July 1, 2022 by Viking

[shru]

On 6/30/2022 at 5:30 PM, Viking said:

Energy right now is looking like steel and lumber did a year ago. The energy companies are making obscene amounts of money. But unlike steel and lumber it looks to be like the profits for energy companies will likely remain higher for longer. If we get a further sell off of energy stocks (on recession fears) it might be time to increase exposure again. Energy has been my best ‘buy the dip’ trade the past 3 months (paid out every time)…

 

My usual buy is Suncor. But i am starting to look at a few of the smaller producers. MEG is looking interesting but might not get much love until more debt is paid down. I like that they are unhedged. 
 

What smaller energy producers are board members big on right now?

 I like Parex Resources.

[Spekulatius]

As for China, I think their construction industry is seeing a significant decline and hence energy consumption from this part of their economy should decline, most likely permanently.

Construction means steel, concrete, trucks and heavy equipment etc all of which consumes significant amounts of coal, diesel etc.

 

As China transitions from an infrastructure/ Capex led to a more consumer oriented economy and should need less energy.

 

As for demand, I expect significant demand destruction from higher prices in emerging markets first.

 

The rigzone link talks about oil inventories only, but not inventories from oil refining which are up. The refineries in the US have taken advantage of the huge spreads and probably refined what they could, hence the low crude inventory (in the US).

 

If I had to make a short term bet it would be  that crude prices likely go where they were before the Ukraine invasion into the $80-$90 range short term. I don’t think they go much lower than that.

Edited July 1, 2022 by Spekulatius

[Ulti]

http://www.gasprocessingnews.com/news/canada-sees-repsol-lng-as-fastest-way-to-boost-gas-supply-to-europe.aspx

[mcliu]

Gas & Diesel:

[SharperDingaan]

Just to add balance .....

 

Off shore 'green field' long term oil supply is pretty much done. What does take place will be primarily consolidation: field extensions on existing infrastructure, extending reserve life to lower annual depreciation, and lower unit costs via higher throughput. Manufacturing.

 

Existing long term supply is being run-off, and not being replaced. The 25-40 yr reserve, whether off-shore or a tar-sand mine, spitting back the bulk of its excess maintenance capex for years to come. Maintenance capex itself being primarily new investment in C02 sequester within the depleting field. ESG.

 

SPR releases eventually have to be replenished, and they are globally being run down in a big way. Can't use inventory to buffer price hikes when you don't have any, and can't refill without raising demand (and price) for an extended period. US gas prices are ridiculously low vs Europe/Asia, US on-shore refining capacity is at end-of-life, and EV economics materially improve as the cost of gasoline rises. ESG, higher prices, widespread US disruption.

 

In the US, short-term thinking dominates (in politics at most, the 2 yrs until the next mid-term election). Whereas, these trends are long-term, and ill suited to US thinking. Volatility.

 

All of which adds up to higher prices for quite some time, lots of disruption, and lots of volatility. All on top of the rising/falling tide as the worlds economies progressively move out of Covid. Swing trades and headlines as your new friend.

 

All good 

 

SD 

 

 

Edited July 1, 2022 by SharperDingaan

[Viking]

The current sweet spot for energy looks to be refining where margins are nuts and look like they may stay high for a while. Q2 earnings for anyone with refining in their mix will be huge. Time to learn more about refining. 
—————

Looking way, way out… like to the fall (4 whole months away…. an eternity away for Mr Market) what will Europe (entering winter) and the nat gas picture look like?

Edited July 1, 2022 by Viking

[SharperDingaan]

Be cautious around refining; it's the obvious place for a 'temporary' windfall tax. Refiners are also often 'vertically' integrated, and not stand-alone businesses - for very good reason.

 

Europe will likely have some kind of residential domestic price cap on gas this winter. Very likely a similar kind of price cap on key items in the CPI calculation as well.

 

Inflation that cannot be reduced through higher interest rates - swept under the rug through price caps financed via long term state debt issuance (ie: tied up in a condom). Energy continues to rip, voters express their thanks, and Ukraine effects sterilized. Tried and tested (AIG), and very German. 

 

SD

Edited July 1, 2022 by SharperDingaan

[LearningMachine]

2 hours ago, Viking said:

The current sweet spot for energy looks to be refining where margins are nuts and look like they may stay high for a while. Q2 earnings for anyone with refining in their mix will be huge. Time to learn more about refining. 
—————

Looking way, way out… like to the fall (4 whole months away…. an eternity away for Mr Market) what will Europe (entering winter) and the nat gas picture look like?

 

The other thing to keep in mind regarding refineries alone is very significant PP&E replacement in times of inflation.  Refineries in the distant past have been better than oil in some years due to stability of refinery earnings, but going forward with inflation, you have to worry about inflated replacement capex with refineries eating up FCF and not have it available for shareholders. 

 

That said, case could be made for vertical integration of both oil and refineries to mitigate risks with each, i.e. mitigate risk of oil volatility that comes with oil alone, and mitigate risk of inflated replacement capex that comes with refineries alone. 

Edited July 1, 2022 by LearningMachine

[Spekulatius]

21 minutes ago, LearningMachine said:

 

The other thing to keep in mind regarding refineries alone is very significant PP&E replacement in times of inflation.  Refineries in the distant past have been better than oil in some years due to stability of refinery earnings, but going forward with inflation, you have to worry about inflated replacement capex with refineries eating up FCF and not have it available for shareholders. 

 

That said, case could be made for vertical integration of both oil and refineries to mitigate risks with each, i.e. mitigate risk of oil volatility that comes with oil alone, and mitigate risk of inflated replacement capex that comes with refineries alone. 

well, that's true for E&P's as well, as they need to replace their reserves. Drilling and exploration will get more expensive. Both tend to be expensive when oil is expensive and cheap when oil is cheap creating the Catch 22 that contributes to the boom bust cycles.

[LearningMachine]

16 minutes ago, Spekulatius said:

well, that's true for E&P's as well, as they need to replace their reserves. Drilling and exploration will get more expensive. Both tend to be expensive when oil is expensive and cheap when oil is cheap creating the Catch 22 that contributes to the boom bust cycles.

Unless you invest in an oil company that has long lasting reserves and doesn’t have to spend on exploration

Edited July 1, 2022 by LearningMachine

[SharperDingaan]

It is more along the lines of having secure feedstock (downstream), and raising the value of what comes out the ground (upstream). Control the whole value chain, and it no longer matters whether you are making your money on the upstream or downstream sides of the chain. What matters is that you have control, and the scale to take advantage of opportunities as they arise.

 

SD

[jfan]

A Decent overview on the oil markets with Josh Young

 

 

[Viking]

@jfan i was just about to post the same video (just watched it). Lyn Alden pointed listeners to Josh Young in one of her recent video’s so she obviously follows him. Anyone who wants to understand the current state of the oil market would be well served to watch Josh’s presentation. It is a fantastic summary of the current state of the oil market with lots of good historical information. Logical. Fact based. Not promotional.

 

For those wanting to understand why Warren Buffett just dropped tens of billions into oil companies, paying what look to be peak prices… watch the video. There is a structural imbalance today in the oil market (demand > supply) that cannot be addressed in the short term (absent a severe recession like 2008). So oil prices will remain higher for longer… And there is a very good chance oil prices will go much higher. $150 oil is not a crazy number. And expect crazy volatility (like we are currently seeing).

Edited July 2, 2022 by Viking

[HeadOfLeverage]

I fully agree except at the end when he stated that energy could 5x from 5% to 25% of the S&P500 seems somewhat promotional to me 

[SharperDingaan]

A $200/bbl spike is not unreasonable, but the mystery is for how long ...

However, companies are not going to be able to cut back on variable dividend/buyback commitments, and in most cases that is around 60% of FCF once debt has been paid down. At $200/bbl FCF may be spectacular, but only 40% of FCF will go to new drilling - not the more customary 100%+ under drill baby drill. It's going to take a long time to get back to 'normal'.

 

It's also useful to research how DUC inventory works. Uncompleted wells are just wells awaiting fracking, casing, clean up and tie-in, typically coming out of inventory on a LIFO basis. They are mostly horizontal wells, and cannot be fracked until casing is available to hold the hole open. Once fracked, for the cracks to remain open they need to go into production fairly quickly.

 

Because labour, sand, chemical, casing, rigs, pressure pumps, etc. are in short supply, it is taking longer to put wells into service. Hence, DUC inventory is a good 10-20% higher than it ordinarily would be. The inventory IS there - but as supply chain issues unwind ... it is going to shrink quickly. Beware the head fake.

 

SD 

 

Edited July 3, 2022 by SharperDingaan

[Viking]

I think the next inflection point for the Canadian producers will be when they have hit their net debt targets. Much of what they are earning right now is largely masked because it is going to debt reduction - and the real benefit to shareholders is seen over the long term. (The opposite of what happens to companies that take on a bunch of debt - which usually boosts short term results).
 

It looks to me like the sweet spot will be Q2 of 2023. By that time most Canadian producers likely will have hit their final net debt targets. And at that time 100% of what they earn will likely be returned to shareholders. And it oil continues to trade +$100 the returns for shareholders will be crazy. If oil goes to +$150… well, we can all dream…

—————

The fly in the ointment might by M&A. We are already seeing some of it. Cenovus recently purchased assets from BP; but so far these purchases look pretty rational and at fair prices (cheap if oil prices stay elevated). We know most non-Canadian publicly traded producers are desperate to exit their Canadian oil sands assets so there are lots of sellers. The problem for Canadian producers is they have been aggressively paying down debt over the past 18 months which has been delaying the big payback for shareholders. And if they now start making big acquisitions before shareholders get more fully rewarded it will create quite the optics problem (unless the price is low and/or the strategic fit is compelling). 

Edited July 2, 2022 by Viking

[Spekulatius]

4 hours ago, HeadOfLeverage said:

I fully agree except at the end when he stated that energy could 5x from 5% to 25% of the S&P500 seems somewhat promotional to me 

There are more faulty assumptions in his video, like the fact WTI has decoupled from equity prices. While I think that equity prices will be correlated to WTI spot, it makes no sense that those curves should be identical. He is also neglecting  that a stock in downturn can be zero and never recover while underlying commodity can recover most likely. So logically a commodity stock index will not fully recover even if the underlying commodity does in this case.

 

Like most reports, it’s way to US centric. Why do we bother looking at US data like inventory levels so much when it’s only ~10% of the supply and demand? Makes no sense. Better check out the EIA reports which look at the world wide supply and demand situation. Those also indicate a tight supply/ demand situation, but at least it’s more balanced.

https://www.iea.org/reports/oil-market-report-june-2022

[SharperDingaan]

2 hours ago, Viking said:

I think the next inflection point for the Canadian producers will be when they have hit their net debt targets. Much of what they are earning right now is largely masked because it is going to debt reduction - and the real benefit to shareholders is seen over the long term. (The opposite of what happens to companies that take on a bunch of debt - which usually boosts short term results).
 

It looks to me like the sweet spot will be Q2 of 2023. By that time most Canadian producers likely will have hit their final net debt targets. And at that time 100% of what they earn will likely be returned to shareholders. And it oil continues to trade +$100 the returns for shareholders will be crazy. If oil goes to +$150… well, we can all dream…

—————

The fly in the ointment might by M&A. We are already seeing some of it. Cenovus recently purchased assets from BP; but so far these purchases look pretty rational and at fair prices (cheap if oil prices stay elevated). We know most non-Canadian publicly traded producers are desperate to exit their Canadian oil sands assets so there are lots of sellers. The problem for Canadian producers is they have been aggressively paying down debt over the past 18 months which has been delaying the big payback for shareholders. And if they now start making big acquisitions before shareholders get more fully rewarded it will create quite the optics problem (unless the price is low and/or the strategic fit is compelling). 

 

A lot of smaller companies will hit debt targets in Q2, Q3 2022. Others already have, and Q2 2022 earnings will be their first variable payouts at their newly stated FCF %. WCP will shock, once the market realizes that even with the dividend rising 22%, the recent 1.7B acquisition could be paid off within 12 months.

 

The oil sands sellers have no market, and there is little rush for buyers to make one. Buyers are focused on dividends and buybacks; buying high carbon production is far down the list, and not going to happen unless it improves ESG/unit. Welcome to stranded assets 

 

SD

[Parsad]

 

10 hours ago, SharperDingaan said:

A $200/bbl spike is not unreasonable, but the mystery is for how long ...

However, companies are not going to be able to cut back on variable dividend/buyback commitments, and in most cases that is around 60% of FCF once debt has been paid down. At $200/bbl FCF may be spectacular, but only 40% of FCF will go to new drilling - not the more customary 100%+ under drill baby drill. It's going to take a long time to get back to 'normal'.

 

It's also useful to research how DUC inventory works. Uncompleted wells are just wells awaiting fracking, casing, clean up and tie-in, typically coming out of inventory on a LIFO basis. They are mostly horizontal wells, and cannot be fracked until casing is available to hold the hole open. Once fracked, for the cracks to remain open they need to go into production fairly quickly.

 

Because labour, sand, chemical, casing, rigs, pressure pumps, etc. are in short supply, it is taking longer to put wells into service. Hence, DUC inventory is a good 10-20% higher than it ordinarily would be. The inventory IS there - but as supply chain issues unwind ... it is going to shrink quickly. Beware the head fake.

 

SD 

 

 

Highly unlikely we see $200 per barrel.  

 

The only oil and gas stock I bought in the last 18 months was XOM around $54 and sold out at $96.  

 

Gas prices in Vancouver hit a peak of $2.42 a liter a couple of weeks ago...today down to $2.069 a liter based on recession fears.  

 

The recession, or perceived recession, may cool demand enough to keep oil at these levels for a while.

 

Cheers!

[SharperDingaan]

Keep in mind there's a big difference between $200 for a few minutes, and $200 for weeks/months ...

 

$200 is just bait, red meat hung out before a pack of dogs to get them to run faster.

The dogs here, being the GS, MS, and the many others in a very frothy testosterone fueled environment. Be a stud! make yourself famous as the first one to nail $200 !!  .... celebrate it with a case of Crystal afterwards !!!

 

My money is on the testosterone.

Nothing to do with whether it is rational or not.

 

SD 

[Ulti]

https://haymaker.substack.com/p/the-inherent-tension-in-malthusian

[Gregmal]

This will all be over once gas station owners just stop being greedy, obviously.